Advanced Corporate Finance
Case Study
Ginny's Restaurant: An Introduction to Capital Investment Valuation by Mark
Mitchell
Candidates: Mladenka Vuchkova; Sanja Pavel
Professor: Vittorio De Pedys
Co-teacher: Stefan Tanevski
June 2020, Skopje
Virginia’s current wealth
Calculation of present value of assets entails discounting future cash flows at the
required rate of return. Present value represents the equivalent of future expected cash
flows. The table below shows present value for Virginia’s assets.
Period Asset Amount PVIF @6% Present Value
0 $ 2,000,000.00 1.0000 $ 2,000,000.00
1 $ 3,000,000.00 0.9434 $ 2,830,188.68
Total $ 4,830,188.68
Therefore, Virginia can spend only $ 2 million today. Future funds cannot be spent
before acquisition.
On the contrary, if she foregoes consumption, the computation below represents
the amount of disposable income available to her after a year.
Period Asset Amount FVIF @6% Future Value
1 $ 2,000,000.00 1.0600 $ 2,120,000.00
0 $ 3,000,000.00 1.0000 $ 3,000,000.00
Total $ 5,120,000.00
Investment analysis
Using NPV, the best investment amount is $ 3 million since it yields the highest
NPV. An investment of $ 1 million has the highest returns when evaluated based on
internal rate of return and profitability index.
Investing in Ginny’s Restaurant generates a higher return for assets and therefore
Virginia’s wealth raises.
NPV
Investment Future Cash PV of Cash
NPV
(outflow) flow flow
$ $ $ $
1,000,000.00 1,800,000.00 1,698,113.21 698,113.21
$ $ $ $
2,000,000.00 3,300,000.00 3,113,207.55 1,113,207.55
$ $ $ $
3,000,000.00 4,400,000.00 4,150,943.40 1,150,943.40
$ $ $ $
4,000,000.00 5,400,000.00 5,094,339.62 1,094,339.62
IRR
Investment Future Cash
IRR
(outflow) flow
$ $
80%
-1,000,000.00 1,800,000.00
$ $
65%
-2,000,000.00 3,300,000.00
$ $
47%
-3,000,000.00 4,400,000.00
$ $
35%
-4,000,000.00 5,400,000.00
PI
Investment Future Cash PV of Cash
PI
(outflow) flow flow
$ $ $
1.70
1,000,000.00 1,800,000.00 1,698,113.21
$ $ $
1.56
2,000,000.00 3,300,000.00 3,113,207.55
$ $ $
1.38
3,000,000.00 4,400,000.00 4,150,943.40
$ $ $
1.27
4,000,000.00 5,400,000.00 5,094,339.62
Simplified Balance sheet for Virginia as of today
Assets
Non-current assets $
Investment in Ginny’s Restaurant 3000000
Current Assets
Cash at hand 1000000
Total assets 4000000
Liabilities and equity
Shareholders’ funds 4000000
Consumption of $ 3.8 million immediately cannot be achieved under the available
circumstances and plans for investment. Only $ 3 million maximum is available for
immediate consumption.
Financing the investment in Ginny’s restaurant using a bank loan.
Capital rationing occurs when sources of free cost capital are exhausted. The best
valuation technique in this scenario is profitability index. PI captures the cost of capital in
evaluating the viability of a project. Virginia should borrow $ 1 million bank loan to invest
in the restaurant since it has the highest profitability index.
Savers versus Spenders
Savers will be willing to invest $ 3 million to benefit from the higher yields resulting
from the highest NPV. On the contrary, spenders will maximize their current consumption
and opt for an investment of $ 1 million to benefit from the highest internal rate of return
and a higher profitability index.
A compromise will arise on the basis of investing the raised funds. Spenders
would prefer quick returns while savers prefer steady long term income in form of
dividends.
Selling smoked hams via internet
Investment $ 2.5 million
Future cash flow $ 3.4 million
NPV = (3.4*0.9434) - 2.5
= $ 707,560
The investment should be undertaken since it has a positive NPV. New balance sheet
after the investment assuming capital increase.
Assets $
Investment in smoked hams 2500000
Investment in Ginny’s restaurant 3000000
Cash 1000000
Total assets 6500000
Liabilities and equity
Shareholders’ funds 6500000
Price of a share before = $ 4000000/200000
= $ 20
Price of a share after = $ 6500000/200000
= $ 32.5
